Yen & 10-year yield spiked. BOJ cited dysfunction in bond market, didn’t mention elephants in room: raging inflation & yen’s plunge.
By Wolf Richter for WOLF STREET.
The Bank of Japan announced today that it would widen the band of its yield peg that kept the 10-year yield capped at around 0.25%. It raised the upper limit of the yield peg to 0.5%, from 0.25%. At the same time, it left its short-term policy rate unchanged in the negative, at -0.1%.
This move by the BOJ opened the door for rate hikes to end its negative interest-rate policy, exit its ultra-loose monetary policy, and join the biggest global tightening cycle in 40 years to fight the worst inflation in 40 years. But that’s not what the BOJ said.
To rationalize the move, the BOJ cited the “deterioration in the Japan’s bond market functioning,” and the “arbitrage relationships between the spot and futures markets,” because the yields of Japanese Government Bonds (JGBs) are “reference rates for corporate bond yields, bank lending rates, and other funding rates.”
But the JGB market disfunction isn’t new. There hasn’t been much of a JGB market for years, with the BOJ holding over half of all JGBs, and with government-controlled institutions holding large JGB positions as well.
The 10-year JGB yield jumped 19 basis points upon the announcement, from about 0.24% to 0.43% and then edged down to 0.39%. It seems the JGB market is not all that dysfunctional after all:
But what’s new in 2022?
The yen’s plunge and inflation. And the BOJ didn’t cite either one of them. But hiking rates will address both.
The yen jumped 4% against the US dollar upon the announcement, to 131 yen to the USD. A gigantic move for major currency in one day.
The yen had gotten beaten down into September this year, when the Fed’s rate hikes collided with the BOJ’s obstinate refusal to exit its negative interest rate policy and yield peg, despite inflation that began to rage.
To prop up the yen, the BOJ started intervening in the currency market in September, selling dollars for yen. It got the dollars by selling US-dollar denominated assets, including US Treasury securities. Over the three months through October, the latest data available from the US Treasury Department, Japan’s holdings of Treasury securities dropped by $121 billion, to $1.08 trillion, and were down by $242 billion from a year earlier. It could have just exited the yield peg and started raising short-term rates earlier this year:
Inflation has begun to rage. Japan’s “core” Consumer Price Index for all items less fresh food – which the BOJ uses for its inflation targeting – jumped by 0.6% in October from September, the worst month-to-month jump since the consumption tax hike in April 2014; and beyond that, since May 2008; and beyond that, since the consumption tax hike in April 1997.
The November CPI data will be released in two days; maybe another bad surprise that the BOJ is preparing for by raising the cap of the yield peg to pave the way for actual rate hikes.
On a year-over-year basis, “core” CPI jumped to 3.6%, the worst since 1982. Even the consumption-tax-hikes couldn’t accomplish that. It shot through the BOJ’s 2% target in April:
The BOJ has already made other moves to tighten policy.
Total assets on its balance sheet have declined by over 5% from the peak in April.
And over the weekend, it was reported that the Japanese government and the BOJ were weighing changes to their agreement, dating back to the beginning of Abenomics in 2012, which started the crazed QE by the BOJ. Those changes would be worked out with the new BOJ governor after Kuroda departs in April when his term ends.
Kuroda is the architect of the crazed QE and interest rate repression that was part of Abenomics. And not a lot of changes can happen with him still at the helm, so the raising of the yield peg by 25 basis points was quite a step – and big surprise for the markets as you can see from the reaction in the currency market and the bond markets.
It now seems likely that the BOJ, once under a new governor, will do a monetary review, out of which will come a new policy arrangement that does away with the Abenomics-dictum of QE-and-0%-rates-at-all-costs and prioritizes keeping inflation under control, thereby officially joining the global tightening cycle.
Implications for yields in the US and elsewhere.
Japan was the last holdout for ultra-low global funding costs – the last “free money” — after the “free money” has vanished from other central banks when they started hiking their policy rates. By allowing the 10-year JGB yield to drift higher, the BOJ is beginning to very gingerly step away from this role. And so the last source of “free money” begins to dry up.
In response, the US Treasury 10-year yield jumped by 10 basis points to 3.69% at the moment, and the German 10-year yield also jumped by 10 basis points to 2.30%.
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